Prepaid card use is growing rapidly. Is this a good thing?

by Peter Andrew

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Do you suffer from vertigo (or, more correctly, acrophobia: a fear of heights)? If so, you should probably avoid creating a mental picture of a graph derived from Mercator Advisory Group's projections for prepaid card usage in the U.S. There's a real danger you could get a dizzy spell, and bump your head on the x-axis. Mercator reckons that $28.6 billion was loaded onto prepaid cards in 2009. It expects that figure to top $201.9 billion next year.

Who uses prepaid plastic?

About 13 percent of U.S. households had a prepaid debit card last year, according to research published by Javelin Strategy & Research on April 11. So who lives in those households? Javelin says that this form of plastic is particularly popular among Generation Y and other youngsters, along with those who don't use traditional banking products (often because they don't have access to them). In a press release, Beth Robertson, the company's director of payments research, explained the appeal of prepaid debit cards:

Today's prepaid features match and even surpass the features of many checking accounts. Functionality that can enable consumers to manage their account using their mobile device or social media account, establish and build a history that can be used for credit-issuing, or enable person-to-person transfers provide high value to under-served consumers.

Some prepaid cards aren't so great

On April 12, the day after Javelin issued its report, Consumer Action published its own. And this exposed that the story of prepaid cards isn't unrelentingly rosy. Like others before ("Senator proposes new rules for prepaid debit cards"), Consumer Action warned against the numerous "gotchas" that await the unwary. Four of these are:

Sneaky fees. With some cards, you pay to call customer service, you pay inactivity fees if you don't use your card, you pay to load money, you pay to use ATMs, you pay if a transaction is declined…These and other charges can quickly add up.

No FDIC insurance. If your deposited funds aren't held at an FDIC-insured institution, if your card issuer goes bust, you could lose your money.

No regulation. If you and your card issuer fall out, there's no authority to go to bat for you. And, by the way, there's no legal obligation on issuers to disclose fees upfront.

No statutory protections. Suppose you lose your card or it's stolen. Even if the issuer promises to help you out, such programs are often voluntary and could be difficult or impossible to enforce.

All of this sounds scary. However, there are some good prepaid debit cards out there. The golden rule, as with choosing traditional credit cards, is to carefully comparison-shop before you take on plastic.

Consumers speak up about prepaid cards

Yet that (comparison shopping) is precisely what consumers don't do, or very rarely, according to yet another April report on prepaids, this time from the Pew Health Group's Financial Security Portfolio. Pew's research was based on a series of focus groups comprising prepaid users, which were conducted last November in Houston and Chicago. It found: "Few participants comparison shop for a prepaid debit card. Most picked whichever one was convenient or recommended to them." That could be an expensive mistake.

Pew's focus groups provided some interesting insights into other consumer attitudes. Here are some quotes:

I don't like the fees on prepaid debit cards. ... It costs to load (them). It costs $3.95. I don't like that I pay the $3.95, but I'd prefer to pay the $3.95 than have to deal with the things that I know that people go through with their checking accounts. I'm good with my checking account. Nobody wants to pay extra fees. If we had to, I'd take the $3.95 any day over the $35 overdrafting or for some other fees. (Female participant, Chicago)

It was like, "Ma'am, you get charged for calling customer service." "I'm getting charged now for calling you all about the money that I got charged?" She was like, "Yes, I'm sorry." I was like, "The next time I load my card, I have to pay for the fees that you charge me for talking to you right now?" "Yes." "Okay, 'bye." (Female participant, Chicago)

Because I want my money back. Give me my money. It's my money, and if I put it on your card, I deserve to get it back. I think they should be regulated by the FDIC. (Male participant, Chicago)

If you have a prepaid card with $500, it's a $500 limit. There's $500 on it. If you have a credit card with $500, one, you don't actually have $500. You just have this imaginary $500 that you have to pay back. Even though you say, "Oh, it's fine. I'll just put X amount on each month and it will be gone." That might have happened, and also now, you're into the interest rates and all these things, and you're not paying it, and they're mad at you. Now, your credit would be down. If you have money on your prepaid card, you're not going to not pay it off because it's already paid. (Female participant, Chicago)

Credit cards vs. prepaid debit cards

That last quote seems especially revealing. If you're bad at managing your personal finances (and some of the most intelligent and successful people are), then a carefully chosen prepaid card could be ideal for you.

However, if you have the self-discipline to use a mainstream credit card responsibly, then there's no real advantage to opting for a prepaid debit card. Bear in mind that some prepaid debit cards are perfectly legitimate and fair, but in general credit cards have significant advantages over prepaid debit cards, including:

By all means use a prepaid debit card if you aren't ready or can't qualify for a revolving credit card. A prepaid debit card can give you the convenience of paying with plastic while you get your financial footing.

Published 04/23/12 (Modified 04/27/12)

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Hi Jennifer,Thanks very much for your comment. I'm glad you took the opportunity to present the NBPCA's viewpoint.To be fair, I don't think I suggested that all prepaid cards have weak consumer protections, but some of them certainly seem to. Both Consumer Action and Pew appear to share that view.It's particularly good news that your association is supporting improvements in consumers' ability to comparison shop for prepaid cards. That, perhaps more than anything else, should help drive out the bad players in the industry and boost the appeal of the good ones' products. Please let IndexCreditCards.com know how your pilot programs turn out.All the best,Peter

The Network Branded Prepaid Card Association (NBPCA) is supportive of tools to help consumers comparison shop and better understand how their prepaid cards work so they can find the card which best fits their personal needs. Some NBPCA members began testing a standardized fee comparison table for consumers developed by the Center for Financial Services Innovation (CFSI). We look forward to the results of the pilots.
We disagree with the charge that prepaid cards have weak consumer protections. Payroll cards and most government benefits cards come with Regulation E like coverage without paper statements. Reloadable prepaid card issuers voluntarily offer equivalent protections, and banks who issue reloadable prepaid cards offer FDIC insurance on a pass through basis to cardholders. The card brands, Discover, Visa, MC and American Express offer zero liability protections to holders of consumer reloadable cards which may be lost or stolen, as well as chargeback rights, to the same extent these rights apply to credit cards or debit carts bearing the network's brand.
Prepaid cards are another way for Americans to avoid debt and interest charged, manage their finances, and open the door to our card-based financial system for large segments of our population who may not have access to or qualify for a checking account.
Jennifer Tramontana, Network Branded Prepaid Card Association (NBPCA)

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